Foreign Aid and Bad Government

Helping entrepreneurs is the right approach.

By

Iqbal Z. Quadir

Updated Jan. 30, 2009 12:01 a.m. ET

Barack Obama has talked a lot about changing the way America relates to the world, and few areas are as ripe for reform as our policies on foreign aid. They have contributed to economic stagnation in poor countries and deprived America of large export markets. Entrepreneurship, not aid, is essential to rejuvenate markets in the developing world and, in turn, help America prosper.

During the Cold War, the U.S. instituted a policy of sending money to governments in poor countries to buy their political loyalty. While studies show that sending aid to foreign governments creates allegiance, it does not lead to economic progress. Instead, it makes governments in poor countries dependent on the U.S. rather than their citizens' taxes.

Pakistan has been one of the key recipients of U.S. aid over the last six decades, but there has been no real progress as a result. Pakistan is riddled with problems that are rooted in the disproportionate power of the state. Aid has only boosted that power.

In contrast, Malaysia saw its economy grow at twice the rate of Pakistan's over the same period of time. Fueled by trade rather than aid, Malaysian economic prosperity is decentralized, and its reliability as an ally much greater.

Tragically, the Cold War aid approach actually preserves suffering in poor countries. Aid empowers bureaucracies, promotes statism, and weakens government incentives to boost tax revenues through growth. Economic assets are often kept in the hands of the state, leading to monopolies, stagnation and extortion. All of this hurts entrepreneurs, who have the potential to create wealth and promote governmental accountability.

The history of Western economic and political advancement illustrates that it is the economic strength of citizens -- not governments -- that gives rise to checks and balances.

A case in point is England, where a lack of outside money created real accountability. In the 13th century, after the advent of property rights, the British monarch was forced to convene a group of citizens as a tax-legitimizing device. This group, known as the parliament, capitalized on the monarch's chronic need for money and made sure the monarch did not gain financial independence. Every time the monarch wanted to pass a new tax bill, the parliament obliged only after exacting more liberty from the crown. Over time, it was parliament that emerged as the more powerful branch of government. The monarch's shortage of money and a lack of outside aid were key to England's democratic success.

President Obama now has the opportunity to adopt a new aid approach that will actually help citizens. Such an approach would demonstrate our faith in democracy and serve long-term American interests.

What should this plan look like?

First, America must remove trade barriers on exports from the poorest countries, regardless of trade policies in those countries. With global market access, poor countries would automatically attract private investment, despite their institutional weaknesses. These institutions would become stronger over time as businesses flourish. Private investments capitalizing on access to global markets would necessarily employ low-cost labor, thus creating jobs.

Next, small entrepreneurs can be bolstered with seed money in the range of $25,000. Small entrepreneurs create jobs, products and services that form the bedrock of flourishing democracies. With some tangible changes in its operation, the International Finance Corporation (IFC) within the World Bank Group could promote development through entrepreneurs. The World Bank should stop lending to governments and be absorbed into the reformed IFC.

Third, America could give $1 million to match any grass-roots group capable of raising $1 million to establish a health clinic. These clinics -- one thousand could be built with $1 billion -- could provide crucial services to poor citizens and generate goodwill towards America.

In short, America should stop pouring billions into bureaucracies to buy short-term alliances and focus its efforts on bottom-up entrepreneurship. This would increase America's popularity, alleviate poverty, and promote real democratic change in these developing countries.

We should encourage governments to be sustained by citizens' taxes -- that is, democracies. Democracies will be enduring allies of America.

Mr. Quadir is founder and director of MIT's Legatum Center for Development and Entrepreneurship, and founder of Grameenphone, the largest cellphone company in Bangladesh.

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